Updated on 09.02.14

5 Big Questions For First Time Home Buyers #2: What Does It Really Cost?

As I begin the process of locating and buying my first home, my mind is loaded with questions. This week, I’m answering the five biggest ones (for me, at least) in detail. Other questions involve a home buying gameplan, hiring an agent, hiring a home inspector, and closing costs.

Whenever I’ve talked to people about the costs of home ownership on a month-by-month basis, I’ve heard some vastly different numbers. Some people claim that it’s incredibly cheap and go on and on about how good of a deal it is; others say they had no idea how expensive it can be.

Cost of Owning a House

I spent some time researching the typical cost of home ownership on a month-over-month basis and I’ve came up with this basic equation for determining the monthly cost:

Monthly cost = mortgage payment(s) + property taxes + insurance + maintenance/improvements – tax benefits

Let’s walk through each of these elements and use an example (who we’ll call Jim) to see how much he can expect to pay each month. Jim wants to buy a \$175,000 house in rural Iowa. He has no down payment, but has found a lender who will give him a full mortgage because he has stellar credit. He borrows \$175,000 at 6.25% for 30 years.

Mortgage Payments

The mortgage calculator at Bankrate.com reports to us that Jim will be paying \$1,077.51 per month to pay off his mortgage. That’s a pretty hefty start.

Property Taxes

After doing some research with Google, Jim discovers a calculator for property tax in the area where he will live. The annual property tax on a \$175,000 home comes out to \$2,391.36, which is basically \$200 per month for property taxes.

Insurance

After calling up an agent recommended by a friend, Jim finds that he can get a homeowner’s insurance policy he’s comfortable with for \$950 a year. That comes out to about \$79 a month for insurance.

An aside: most lenders, when calculating the “cost of home ownership,” include the mortgage payments, the property taxes, and the insurance. They generally don’t subtract the tax benefit, nor consider the additional cost of maintenance or improvements. They use this number, usually abbreviated PITI (principal, interest, taxes, and insurance), to determine roughly how much to lend to you. Thus, a lender would estimate Jim’s PITI as \$1,356.51 per year. The lender would then calculate this as a percentage of Jim’s annual salary (\$60,000) to come up with 27%, within a safety area of “lendability.”

Maintenance costs

This seems to be a big variable based on different living situations, but a fair estimate of an annual investment here is 1% of the cost of the home. So, since Jim is paying \$175,000, he should figure \$1,750 a year in home maintenance costs, or about \$150 a month to keep up his home.

Tax benefits

Here’s the good part: the interest on that home loan is tax-deductible. Rather than doing a large calculation here that tries to remove the principal from the home loan as well as figure in the additional state and local tax benefits, we’ll just multiply Jim’s federal tax rate (28%) by his monthly mortgage payment (\$1,077.51) to get a rough estimate of how much he’ll save each month in taxes: \$301.70. I’ll round that down to \$300 to ward off a bit of naysaying.

So, what’s the total damage? If we replace the numbers in the equation above with the numbers we found, Jim will incur an expense of just about \$1,500 each month to buy his house, but will make back about \$300 each month in income tax savings, leaving him with an average monthly cost of home ownership of about \$1,200.

Doing my own calculation with vaguely similar numbers made me feel a lot more comfortable with home ownership. I estimated a bit higher than 1% for monthly home improvement expenses for my own reasons; regular readers of The Simple Dollar probably already know that I want a very, very nice kitchen. In the end, though, these numbers made me feel much better about the upcoming purchase, not in that I thought it was cheaper or more expensive, but that I finally had some real numbers to think about.

1. Keter says:

I ran into a nasty surprise after purchasing my first home. I did exactly the kind of calculation described, and came up with a monthly cost of slightly less than described in the article. My home purchase price was somewhat lower, and my property taxes and insurance somewhat higher. I was comfortable with that amount as it was only \$200 more per month than I was paying to rent an apartment.

Over the next 5 years, the insurance doubled from \$800 to \$1600, and the taxes nearly doubled from \$2700 to \$4600. Yes, I protested, but to no avail. It’s going to take a class action lawsuit to get this taxing district to back down. And I can’t find an insurance carrier who will give me a break due to the unique construction of my home — they insist on using a standard table that doesn’t apply to my property.

I’m just sick about this — I’m paying the equivalent of more than 5 mortgage payments per year for stuff I don’t even use. The majority of the taxes are for the schools, and my children are long since grown; my home is made of concrete and steel, I will likely never need to claim on insurance for anything because it is almost completely invulnerable — I would drop insurance entirely and put the money into an emergency fund instead except my mortgage requires it.

So it just goes to show that no matter how carefully one researches and plans, things can change dramatically in ways that cannot be anticipated, and you’re left paying for things that make no sense whatsoever.

2. HC says:

It’s also worth noting that in places that AREN’T rural Iowa, many homeowners will have to pay condo association or homeowner’s association fees. (These often cover some portion of utilities or maintenance. However, most people pay out more than they get back, at least directly.)

In my area, even 1-bedroom condos have fees of between \$150 and \$400 a month.

3. Kevin says:

Keep articles like this coming. I am eating this stuff up as we get ready to buy a house (hopefully) a year from now.

@Keter – Do you have a dome home?

4. Ralthor says:

I am also trying to decide how long I am going to save money until I buy a house, so I love these articles.

I have a question about your tax break calculation. Only the interest is tax deductible and the first year you are paying in the 7K range of taxes (I think with your example). At best you are getting a \$200 break a year, probably closer to \$175. This tax savings will also decrease each year.

I think you were just making it easier to calculate, but to be safe I would round by over estimating expense and under estimating savings.

Just as a side note (and maybe you will hit this in a future article), but if you are going from an apartment to a house you have to take into account, water, sewage & garbage (usually free at apartments), increased electric/gas costs (for heating and powering a larger area), lawn mower, ladder, hoses, (more furniture?) and all the other stuff you don’t need at an apartment.

5. Ace says:

I agree with Ralthor’s adjustments. The tax savings are grossly overvalued in the original article, both for the reasons Ralthor mentions, but also because the only savings come from the tax on the difference between your itemized deductions (including mortgage interest and taxes) and whatever your standard deduction might have been.

Of course, in the long run, home ownership is almost always a good deal because you end up with a real asset that generally appreciates in value and is largely exempt from capital gains tax.

6. Giorgio Campo says:

Great article- just be careful; home ownership is a very serious endeavor- take a peek at what is going on in Chicago..

7. David Hunter says:

A good article as usual Trent!

However in regards to home maintenance I would try and be a bit more precise, the price of the home is little guide, because you pay both for the land and the house, and often the difference in values between places is more due to the value of the land than any difference in between houses. I’d find some other measure and try and figure it out on the specifics of the house itself.

Cheers
David